Fortescue Metals still riding the roller-coaster to China

Matthew Kidman

VALUING iron ore miners should be easy for investors. The company digs up the ore, puts it on a ship and sells it to a steel mill in Asia. How can such a straightforward business be so opaque to shareholders?

Several times this year we have written about the leveraged nature of Andrew Forrest's Fortescue. Australia's third-largest iron ore play hit the wall in August when iron ore slumped from $US140 a tonne to $US86. In the middle of tripling production, Fortescue was forced to restructure its debt. Within days it trumpeted a new debt deal, with the repayment schedule extended and the production plans scaled back.

Over that period the iron ore price rallied to $US120 and Fortescue's shares jumped 50 per cent to $4.31 in a matter of weeks.

Since then the stock has floundered and is back at $3.72. At its annual meeting Fortescue outlined its cost of production and where it was positioned compared with its competitors.

The investment market generally believed Fortescue sat nicely behind the big boys - BHP, Rio Tinto and Vale - and well under the high-cost producers in China. This meant that with the debt burden eased, the company could sustain an iron ore price of around $US100 a tonne, with the Chinese companies falling by the wayside first.

What was not well known was the ability of the Chinese government to support local producers by cutting $US25-a-tonne taxes to keep them in the game. A final decision has not yet been made. But an easing of the taxes charged would see the Chinese players at or below Fortescue's costs once interest bills are taken into account. With iron ore around $US115 a tonne, investors are getting nervous now the high demand is passing by.

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Fortescue could be the marginal producer of iron ore, and if demand drops, the share price might decline sharply. But if prices firm, Fortescue should rally. Tread carefully.

Cardno waiting game

IT IS always tempting to buy a company that has downgraded its earnings because it looks cheaper. Investors, though, should be highly circumspect of this approach because companies that downgrade once have a heightened chance of repeating the dose.

Engineering services group Cardno has been a thumping success since it listed on the ASX in 2004. Soon after listing, it hit a low of $1.20 a share, before rising to $8.40 earlier this year. The company has steadily increased earnings through a combination of organic growth and acquisitions.

Recently it issued a profit warning that prompted analysts to downgrade their 2013 earnings-per-share forecasts by between 5 and 10 per cent. Meanwhile, the share price has slumped more than 20 per cent. The price to earnings (P/E) multiple has shrunk from shy of 13 to just under 11 times.

Investors should be careful. Cardno's explanation of the downgrade was vague. It stated that organic revenue growth was healthy at 7 per cent but margins were under pressure. It went on to say revenue was flat to shrinking in Australia. All this adds up to adopting a wait-and-see approach. The half-year result in February could be enlightening.

Designs on Altium

IT NEVER fails to amaze how the market throws up opportunities. Since July 2011 software designer Altium has risen almost 1500 per cent, from 8¢ to $1.18, and it now has a capitalisation of $130 million. If we deduct the $12 million of cash on the balance sheet, then we are paying $118 million for the business.

Does that mean the ride is over? The company reported an underlying profit of $13.2 million for the year to June. This number is before tax and it is always critical to fully tax a company to generate a genuine valuation. So after tax, the company is trading on a P/E multiple of about 12 times.

The question now is how much can the new management team increase earnings from here. The first-quarter update revealed revenue growth of 7 per cent. But the commentary was skewed towards better return for shareholders and keeping a lid on costs.

If it can keep this growth going and a rein on costs, then 15 per cent earnings per share growth for 2013 is not out of the question. That would mean the company is trading on a 2013 P/E of 11 times, which is undemanding. We should be keenly awaiting the December-half result to see what management can deliver. A positive outcome could lift the stock towards $1.50.